· 2 min read · Features

New Government pension rules for high earners will create serious challenges for HR

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New government rules will make the pensions tax regime an administrative quagmire in 2011. The reason for this lies within a document that has far-reaching consequences for HR managers - a consultation paper on the 2011 tax regime for pensions, published as part of the December 2009 pre-budget report.

The government had previously announced that individuals with income of at least £150,000 will face a restriction on the tax relief available on their pension savings. The more recent consultation paper has, importantly, widened the definition of income, and now includes employer contributions to pension saving. This means that the regime will now affect a significantly larger number of people: 300,000 employees according to the Government, rather than the original estimate of 230,000, an increase of 30%.

The impact

So what will this mean for the HR team? The impact will take three main forms: communication, carrying out the calculations needed to determine which employees are affected, and benefit design.

HR teams need to communicate proactively with people who are likely to be affected, telling them what the changes mean. This is not a simple task. The first challenge is deciding who to contact. The £150,000 threshold includes, as well as pay and pensions contributions, external elements such as rental income and share dividends which HR managers won't know about. So do you contact those earning, say £100,000 or more? Or contact everyone? It's a difficult decision, and will depend on the proportion of higher earners within the company in question. Additionally there are currently no provisions for the earnings threshold to rise along with inflation, so HR teams may see an increasing proportion of their organisation's workforce affected in future years. A potential response would be to remind employees on a regular basis (perhaps annually) to ensure new entrants to the income bracket are contacted.

Once an employer has flagged the issue to its employees, there remains the tricky process of determining exactly who is affected.The valuation of the company's pensions contributions may be particular challenging. Applying the HMRC rules to quantify what a defined benefit (DB) promise is worth may not be a straightforward task. Although much of this work will be led by the pensions scheme, it will mean that more individuals within the HR department will need to have a thorough understanding of the company's pension arrangements. There may also be a need to invest in extra IT and processes.  One particular burden that will fall to HR teams is to ensure benefit statements are provided  to all employees whose non-pensions income from the employment is at least £130,000 (see box-out). These will have to be requested very quickly, as pension schemes must produce them by 6 July, only three months after the end of the tax year.

Few HR departments will want to risk the wrath of disgruntled executives who find that the information they are getting about their pension tax position is wrong or late.

Remuneration packages themselves may also need to change, for both existing employees and new hires, as these individuals will want to pursue the most tax-efficient path As part of this process, company pensions are likely to become increasingly unpopular among higher earners. The possibility of paying higher rate income tax on the pension contribution and on the pension itself is very unattractive.  These executives may be looking for cash instead of pension or will want access to alternative types of pension plan where this double taxation is avoided. Some employees may also be looking for the flexibility to choose which side of a tax year they receive a bonus payment  and to have the ability to defer decisions about pension saving until the last minute. In any event, HR and pension teams are likely to receive more enquiries about the options, irrespective of whether the company intends to offer any.

Between now and 2011

While the fundamental principles appear set in stone, the implementation details are not and many pensions schemes will be lobbying for change. It will be crucial for HR managers to understand and engage with this lobbying process - the new tax rules will create both uncertainty and extra work for HR departments, and they need to be involved in trying to make the regime as workable as possible.

Mark Duke, Head of Pensions at Towers Perrin